Receivables management is fundamental to every firm’s cash flow because it is the amount it receives from customers for products or services rendered (net realizable value). Receivables are classified as current or non-current assets. These transactions are recorded on the balance sheet. Current receivables are cash and other assets that a company expects to receive from customers and use within one year or operating cycle, whichever is longer. Accounts receivable are collected either as bad debts or as cash discounts. Non-current assets are long-term, meaning they are held by the company for more than one year. In addition to well-known non-current assets, banks and other mortgage lending institutions have a mortgage receivable account that is reported as a non-current asset.
Bad debt, also known as bad debts, is treated as a per se asset (deducted from an asset in the balance sheet). The contra asset increases with credit entries and decreases with debit entries and will have a credit balance. Bad debt is an expense account that represents receivables that are not expected to be collected by a company. Cash discounts are offered to the customer to entice prompt payment. When a customer pays the bill within the stipulated time which is normally 10 days, a cash discount is offered which is noted as 2/10, which means that if the account is paid If done within 10 days, the customer gets a discount of 2 per cent. Other credit terms offered may be n30, meaning the entire amount: to be repaid within 30 days. The cash discount is recorded on the income statement as a deduction from sales revenue.
Banks and other financial institutions that provide loans experience or expect losses from loans given to customers. As the country saw during the credit crunch, banks issued mortgages to customers who were unable to repay their mortgages due to loss of jobs or other facts surrounding their circumstances at the time. As a result, mortgages defaulted, leading to the foreclosure crisis, and banks foreclosed on homes and lost money. For better recovery of losses, banks secured accounting procedures to assist bankers to report accurate loan transactions at the end of each month or as per the bank’s mortgage cycle. In those credit risk management systems, banks created a loan loss reserve account and mortgage loss provisions. Mortgage lenders also have a mortgage receivable account (non-current asset). By definition, a mortgage is a loan (an amount lent at interest) that a borrower uses to purchase an asset such as a house, land or building and is an agreement that the borrower will repay the loan on a monthly basis and in installments of the loan. is amortized over a specified number of years.
To record the mortgage transaction, the accountant debits the mortgage receivable account and credits the cash account. Depositing cash reduces the account balance. Should the borrower default on his mortgage, the accountant debits bad debt expense and credits mortgage receivable account. Mortgage receivables are reported on the balance sheet as long-term assets. Bad debt expense is reported on the income statement. Having a bad debt expense in the same year in which the mortgage is recognized is an application of the matching principle.
To protect losses from defaulted mortgage loans, banks created a loan loss reserve account, which is a contra asset account (a deduction from an asset in the balance sheet) that holds an amount estimated to cover losses across the entire loan portfolio. represents. The loan loss reserve account is reported on the balance sheet and represents the amount of outstanding loans that are not expected to be paid back by borrowers (the allowance for loan losses estimated by mortgage lending financial institutions). This account is adjusted each quarter based on interest losses on performing and nonperforming (non-accrued and restricted) mortgage loans. A loan loss provision is an expense that increases (or decreases) the loan loss reserve. Loan impairment expense is recorded in the income statement. It is designed to adjust loan reserves so that loan reserves reflect the risk of default in the loan portfolio. In my opinion, the method of estimating loan loss reserves based on all loan accounts in the portfolio does not provide a good measure of the losses to be incurred. There is still a risk of overstating the loss or understating the loss. Hence there is still a possibility that the bank may run at a loss, and this defeats the purpose of the loan loss reserve and provisioning. If loans were classified and estimated accordingly, this would eliminate more loan losses.